Why You Should Invest In B-Class Malls

LOS ANGELES—Retail is changing to destination-driven centers, but Pacific Retail’s Steve Plenge says that there are still big opportunities investing in the right class-B malls in this EXCLUSIVE interview.

LOS ANGELES—Low-grade retail centers are providing big opportunities for retail redevelopment, according to Steve Plenge, managing principal at Pacific Retail Capital Partners. While the retail market is shifting, grade-A retail centers are finding major success, but anything less has “become synonymous with failing,” according to the firm. Plenge says that this is a mistake, declaring that there are major opportunities to redevelop grade-B malls into class-A properties. To find out more about the potential for class-B retail investment and what investors should look for when considering these redevelopment opportunities, we sat down with Plenge for an exclusive interview.

GlobeSt.com: What is the difference between a grade-A mall and a grade-B mall?

Steve Plenge: There are approximately 1100 malls today in the US. They can be broadly categorized as a third A, one-third B and one-third C or dying; however, the definition is much more nuanced. All categories have a minus and plus category, and the standard definition relates to sales per square foot of smaller shops, generally under 10,000 square feet.

A- assets are generally measured at above $500 per square foot, with A+ assets over $750 per square foot. B- malls would generally measure at $300 per square foot and higher, where a B+ quality mall would be above $450 per square foot.

Further definition would take into account a mall’s overall productivity, such as total sales generated at the property including department stores and larger junior anchors. ”A” malls are typically doing over $400 million in sales, where a good B mall is doing above $200 million in sales. These are indicative of the malls drawing power within a trade area.

Even though a B’s total sales are generally half of an A’s, they still represent considerable spending and purchasing power. $200 million or more is a significant sales number within any city, indicating substantial foot traffic, which is generating substantial sales revenue for the municipality.

GlobeSt.com: Why are B malls still a good investment opportunity? What characteristics should investors look for when considering a B mall investment?

Plenge: B malls offer a number of solid investment fundamentals:

They are well located generally, with excellent freeway or major highway locations.

These malls were developed on regional sites when the cities or towns in which they are located were growing rapidly. Over time communities have developed around these properties and the mall now represents a major land holding of +/- 100 acres in markets that today have few spots for new development.

These sites are inefficient in their land use, often built on only 25 percent of the property with huge surface parking areas. Today, as parking ratios decrease, this inefficiency creates significant development potential and the opportunity to add new uses such as multifamily, hotels and office.

B malls are not dead and not dying. They have a reason to exist and generally tend to be assets that have lacked active management or focused capital investment over a period of time. There may be some physical obsolescence, which allows an investor to renovate and refresh an asset, bringing new experiences and a mix of uses, thereby repurposing the property.

Based on our work and research, we believe that people from Gen Z and Millennials to Baby Boomers, enjoy the activity of shopping, but shopping needs are changing. Shopping is an event. Ensuring that it is something people do not get online, it needs to be social and interactive. People-watching has not lost its allure.

Too often investors equate the de-emphasis of apparel at a mall as signaling that the mall is no longer relevant. This is simply not the case.

Restaurants, bars, unusual stores such as local retailers and start-ups, theaters, gyms – large and small, wellness centers, grocery stores, medical facilities, and professional schools, are all part of the evolving mix of a mall.

We have seen through active management, which brings social media to the forefront of operations, and redevelopment that has thoughtful, creative design, has absolutely changed the perception of a property in the eyes of both the consumer and retailer. This positive revival of a property leads to increased sales productivity and can improve the implied value of a property significantly.

GlobeSt.com: How does tenant mix play a role, and how can it help boost a B mall to A status?

Steve Plenge: Tenant mix is very important. Developing a thoughtful, tailored leasing strategy is vital to having a tenant mix that can improve sales productivity and thereby improve the mall’s value. You can enhance the shopping experience and highlight the tenants by creating clusters or districts within a project. For instance, you can add a theater or help showcase an existing theater, by adding nearby restaurant concepts and specialty dining options.

An A or A- mall does not have to have luxury retail to be considered an A asset. The property however, needs to cater to the interests of the trade area, providing the goods and services most desired by the community. There is not a uniform template for malls across the US. Perceptions and needs of the consumer vary significantly from city to city and region to region. Our mall in Salt Lake City has a completely different set of metrics for what the community values compared to our property in San Jose. We tailor each property, first and foremost, to align with the needs of the community when determining leasing strategy and tenant mix.

GlobeSt.com: Retail sales nationally have been flat at best over the last two quarters, with many stores announcing closures. Is retail mall investment risky, especially for lower grade properties?

Plenge: Real estate and retail have always been considered fairly risky businesses. “A” malls have, I believe, significant risk that is being overlooked by many investors when they pay incredibly low cap rates for “core” properties. Store closures and financial stress is also hitting the luxury market as well.

In addition, there is wide spread fear of the Internet today, that it will eliminate the need for bricks and mortar stores. This is a huge over reaction and misconception by investors, which has created market opportunities for quality properties at attractive risk adjusted returns.

In the long run, we believe ecommerce sites will not be able to succeed without a brick and mortar component and pure brick and mortar retailers will not be able to succeed without a strong ecommerce presence. This convergence is happening now, creating new opportunities in the mall space for new retailing platforms.

We look at the current pricing of B mall assets as attractive given the risk profile of these assets. Debt can be obtained at reasonable levels. At Pacific Retail we generally target no more than 65 percent loan-to-value with cap rate spreads of 300- to 400-basis wider than core transactions today. We think this is unique and offers some solid fundamentals and rationale for investing in this sector.

GlobeSt.com: How is retail and the mall experience changing? What does it mean that investors from different disciplines, like multifamily, are incorporating retail into their projects?

Plenge: Everything is changing in the way we shop. It is part of the never-ending evolution of retail, which has been going on for two hundred years.

The way we communicate about retail, the way we interact with our friends about shopping, and the way retailers communicate with us about their stores has drastically changed with social media. There is no more marketing other than through social media.

Today the mall may have community events every day, from a farmers market to a craft beer festival. Now, more than ever and particularly at B properties, malls are taking steps to more actively integrate into the community.

Many institutional owners have consistently focused on national brands. These certainly have a position in a mall, but they are no longer the only force to consider. Solid, well-capitalized local retailers also need to be incorporated into the tenant roster. They offer local flavor, whether it’s a specialty dining experience, cool new apparel store or boutique featuring locally made products. The cookie cutter aspect of many malls needs to change and local flavor is one avenue to transforming the property and customer experience.

Adding a mix of uses also brings new energy to the mall. Some options include providing more green open space for events and gatherings, enhancing landscaping and expanding places to relax. Another new concept is creating areas in a mall that serve as a collaborative work environment. Westfield has recently done this in San Francisco to great success, creating an executive office and technology space.

Outside of the confines of the mall, new development on the property can be a plus for the community and retailers. For instance, adding multifamily housing brings residences close to amenities and provides a built-in customer base for the mall. This increases the interest of a grocery store or service provider in locating at the center and improves the area’s appeal as a vibrant 24-hour destination.

We recently sold a vacant piece of land at one of our centers that we identified as a viable housing site and spent a couple of years working through the process to secure entitlements for multifamily. The sale resulted in a substantial gain that had not been contemplated in the original investment thesis.

GlobeSt.com: What will happen to the malls and shopping centers that cannot be repositioned into class-A assets? What about C and D class assets?

Plenge: Malls do not have to become “A” properties to survive. They do need to remain relevant and purposeful. A “B” mall can stay a B mall, while still improving sales productivity and customer experience, which will enhance value of the property. Acquiring a B property and moving it up the quality spectrum to a B+ asset can generate significant profits.

C and D assets are a much more difficult calculus. These are assets that in most cases are passed the tipping point to remain a mall. They have significant obsolescence flaws, as well as substantial vacancy and declining sales. These are very tough properties to turn around. Investors have been intrigued by very high cap rates (mid-teens), but may fail to appreciate the difficulty in repositioning these assets. In most cases an investor will need to look at other uses and a valuation of the land for an acquisition to make sense as these transactions are much more development focused.